In the 1970s, the Hunt brothers infamously manipulated the silver market, causing prices to climb from $1.50 an ounce all the way to $50, before finally crashing in the early 1980s. Now many silver investors believe the silver market is being manipulated again, but this time, the manipulators are said to be on the short side, artificially depressing the price of silver. Is there evidence to support these allegations?
The Short History of Silver Leasing
Following the precipitous crash of silver in the 1980s, prices stabilized at around $4 to $5 an ounce. These low prices enticed demand, and didn’t take long before the world’s appetite for silver outpaced global production, thus necessitating the draw down of silver inventories.
Normally, such a scenario leads to price appreciation, since individuals and institutions holding stockpiles of silver need an incentive —higher prices—to part with it. But in this particular case, silver did not appreciate to the extent that the laws of supply and demand indicated that it should. Why?
One answer was the new practice of silver leasing. Government central banks throughout the world held stockpiles of silver (as well as gold), but selling it to meet global demand would have invited unwanted scrutiny from various government watchdogs. So instead, central bankers “lent” or leased the silver, effectively dumping it on the market, through private investment-bank intermediaries, in exchange for an annual interest rate and a promise the silver would be returned at a later date.
Leasing made a lot of sense to central bankers. After all, stockpiles of precious metals earned no interest in government vaults, so loaning it out—even at ultra-low interest rates of 1% or less — produced income which otherwise would never have come into being.
Thus, central bankers were willing to supply silver irrespective of the price it was fetching on the open market, and this led to relative price stability even as demand soared and inventories were being depleted.
This lasted for almost twenty years, but eventually, the jig was up. Central banks had finally leased all of the silver they could, and they began demanding interest rates as high as 8%. At these rates, private investment bankers could not hope to sell the leased silver, invest the proceeds elsewhere, pay the central bankers interest, and still hope to out pace the rate of return on silver — so the practice of silver leasing essentially came to an end.
The Concentrated Short Position
With the end of silver leasing, the price of silver was expected to rise. It did, but not to the extent that most silver bulls anticipated it would. A new culprit — a cabal of silver short sellers — was fingered for blame.
That there is a concentration of silver short sellers is no “theory” — it’s fact. As of July 10, just four or fewer traders hold a net short position of nearly 228 million ounces of silver — the equivalent of more than 130 days worth of global silver production. By contrast, the concentrated short position in gold is equal to just forty-five days of global production, and the concentrated short position in crude oil just 1.4 days.
To be clear, what this means is four or fewer traders are selling over 35% of all contracts on the silver futures market. A futures contract is an obligation to deliver a stated amount of a commodity at a stated price and on a stated date. Typically, the sellers of futures contracts “cancel out” their positions by buying offsetting contracts, and vice versa, but occasionally, buyers may take delivery or sellers may make delivery of the underlying commodity.
The price of silver has nearly doubled in the past two years, but this price appreciation has not been met with a reduction in the concentrated short position. This means the four or fewer largest sellers of silver futures are not making delivery of the silver they’re selling — presumably because sellers don’t actually own the silver — but instead, shorts are constantly renewing.
Many silver traders believe the very existence of the concentrated short position is proof positive of manipulation. After all, if this group of four or fewer traders was not constantly renewing their positions, then clearly the price of silver would be higher. In the absence of their persistent sales, other sellers would have to be drawn to the market in order to meet the demand of silver futures buyers (and real silver buyers), and the only way to lure these new sellers in would be higher prices.
But what end are the concentrated shorts serving? One theory is holding down prices for industrial use, but if this was the case, the money the short sellers (presumably large industrial consumers of silver) saved via lower production costs would seem to be mostly eclipsed by the money they lost in the futures market.
Regardless, believers in the theory of silver manipulation say that the Commodities Futures Trading Association (a government agency) publishes concentration data each week precisely because large concentrated positions are tantamount to manipulation. And, if the manipulation is persistent, as has been in this case, then clearly the manipulators must be profiting from it. But how will the story end?
Is the End in Sight?
Regardless of whether the price of silver is being “manipulated,” the fact is the concentrated short position cannot last forever, and most experts believe that when the shorts are finally unwound, the price of silver will appreciate.
For example, one scenario is short sellers will ultimately throw in the towel — much like the Hunt brothers were forced to do back in 1980. Some people fear this could cause such a disruption in the market that chaos would ensue — the market might even need to be shut down. If this were to happen, then the holders of silver futures may not receive their just rewards, but the holders of actual silver most certainly would.
After all, a market shutdown would, by definition, disable the mechanism that has allowed the short sellers to suppress the price of silver. Demand would presumably remain the same, and thus the price of silver would likely appreciate.
Another potential end to the scenario is the concentrated shorts may make delivery of silver — all 228 million ounces. If this were to occur, then short selling would obviously come to an end, and as a result, the price of silver would likely increase.
The final potential end is the fall of silver. After all, it should be assumed that the four or fewer traders taking the short positions are not stupid — they undoubtedly believe that the price is silver is going lower, and they have been remarkably patient thus far. Perhaps production will outstrip demand and the price of silver will go lower. Then perhaps the short sellers will cancel out their positions once and for all, reaping eight-figure profits in the process.
The wisdom of crowds says this is the least likely scenario, but silver traders shouldn’t become overzealous in the certainty that the shorts have to eventually give in and the price of silver has to eventually rise. There are never truly “sure things” in the world of commodities investing, and all positions are to be taken with due caution.